Saturday, 26 February 2011

The portfolio contest between traditional Cap-Weight and Fundamental Weight Index ETFs has become a little more tedious to track manually with the switch by both BMO and iShares to more frequent monthly instead of former quarterly distributions on more ETFs.

It also undermines one of BMO's advantages compared to iShares, namely the automatic, free DRIP program since now much smaller amounts are being distributed monthly, which in many cases won't be enough to buy whole shares. Even with a $100k portfolio, the January and February amounts for ZRE are not enough to buy even one share. Since for ZRR both portfolios have the same holding it won't any difference between them. Therefore, I will simply accumulate the cash for both portfolios until rebalancing at the annual anniversary date in mid July presents an opportunity to re-invest it. The spreadsheet at the bottom of the blog now includes the cash for both January and February distributions (which is anticipating a bit since BMO only distributes the cash March 7th but again it doesn't make any comparative difference).

Cash or no cash, it is quite interesting to see that the Fundamental portfolio has now opened up a significant lead of $1602 since the beginning of the year. It's easy to spot that it is because of the huge leap of the Developed Markets Fundamental fund PXF over its Cap-Weight rival VEU. Both portfolios have positive returns in every asset class! It's just that "some are more equal than others" with bigger gains. That includes Canadian Bonds where the price level of XBB is flat but the cash interest distribution would push its return into plus territory. Nothing is really close to the 1/4 share out-of-whack rebalancing trigger point though XBB is starting to get down there with 21.5% versus its target 25%. If interest rates start to rise then XBB is likely to start falling though equities might too.

Wednesday, 23 February 2011

There is a rule of thumb that says a person can withdraw 4% of the value (as of the date of retirement) of an investment portfolio and adjust the amount every year for inflation without fear of running out of money. A prime proponent of this idea is William Bengen (review of his book here) who based his conclusions only on US data.

The results are not very encouraging: "... from an international perspective, the 4 percent real withdrawal rule has simply not been safe." Using data over a longer period from a different source than Bengen (but which validates Bengen's results about the US), Pfau calculated what would have happened in 17 developed countries using quite generous assumptions and found that in only three other countries - Canada, Sweden and Denmark - the 4% rule would have worked out.

The paper's main aim is really only to get a feel across different countries. It deliberately excludes several extremely important factors that could dramatically alter the specific maximum Sustainable Withdrawal Rate in realistic conditions:

mainly downwards - no adjustment for rebalancing trading and fund management costs to the index data, no taxation on returns, using the stock vs bond allocation that gave the best result, as if the retiree could perfectly forecast the best combo for the next 30 years;

The study confirms another Bengen US finding, though exact figures vary country by country: stocks always comprise a substantial part - at least 50%, some up to 100% - of the portfolio that had the best SWR; for Canadians that was about 50%.

A scary bit to the paper is table 4 (which appears in the blog article version but not in the FPA version). Table 4 shows that for an arbitrary commonly cited 50% equity/50% bond portfolio (as opposed to the stock bond split that gave the best result), in no country would a retiree never have run out of money using the 4% withdrawal rate.

The key question highlighted in the conclusion applies to every country. The past is all well and good but for any particular country, which past will most resemble the future? Will the US or Canada continue to outperform compartheed to everywhere elseor will they revert to some lower international mean? One can simply blindly lower the SWR e.g. to 3.5% or 3%, or try to adjust expected future stock and bond returns using current relative valuation.

The even larger issue for the retiree is whether an investment portfolio with systematic withdrawals is the most appropriate way to fund retirement expenses. I don't believe so. I've already noted objections to the 4% SWR approach by Scott, Sharpe and Watson. The critical correction needs to be that assets should be matched with liabilities in terms of income risk (variability, default) and timing of income.

Monday, 21 February 2011

Black comedy, as in dark, little or no light visible. That's how things are regarding the meaning of the word Return when used for mutual fund performance.

Reader Marypat in a comment on my last post says she is a new investor and asks a simple question: "I was wondering if the returns they report for mutual funds would already include the payment of the MER. For example, one fund shows a 1 year return of 3.8% but it also has a MER of 2.55%. Does this mean that my return is actually 3.8%, or is it 3.8% less the MER?" The simple answer is that the reported Return is net of / after deduction of the MER, i.e. in the example, 3.8% net. The MER gets automatically deducted from the fund by the managers and reduces the fund's asset value. When the net asset value is used to calculate the Return, the MER money is already gone.

MER is not the only Returns-reducing cost, though. There are other costs that get deducted and reduce reported Returns, notably trading expenses and GST. The fund Return also should include the assumption that all distributions are reinvested instead of being received in cash. Finally, there are other possible or variable costs that will reduce Returns but which are NOT shown in reported performance - fund switching fees, one-time front-end sales fees or back-end early redemption fees and income tax (see a previous post on MER vs TER).

I say "should include" because the exact description of how mutual fund Return is calculated seems impossible to find on any official website!

Try to find an FAQ, a footnote in fine print, a pop-up definition in GlobeInvestor or in Morningstar.ca that explains the performance numbers displayed for a fund. Good luck. For a random fund picked from a recent Globe article on Lipper's Top Mutual Funds Over Three Years - the Brandes Emerging Markets Equity Class A - here is the GlobeInvestor Brandes fund info and the Morningstar info. See any explanation of Returns on either website? Another mutual fund database and comparison site, FundLibrary.com, had no detailed definition of Return that I could find under Novice Investor or Q&A. The Glossary entry for Return had this definitional piece of fluff - "The amount of money earned by an investment".

Does the regulatory body Ontario Securities Commission new Point of Sale Disclosure for Mutual Funds document Fund Facts contain the explanation? It's better! - "Returns are after expenses have been deducted" and then itemizes various expenses and fees (except for the GST, which isn't there at all). But there should be a more explicit explanation of which expenses to the investor are included or excluded in Returns data. Are those expenses with a capital E - i.e. only those in item 2) Fund expenses of the How much does it cost section, or possibly the 1) Sales charges and 3) Other fees too? It is a bit artificial to describe the fund's Returns only in strict terms as those after costs directly deducted from the fund on an on-going basis, instead of the investor's Returns which come after deduction of all the other charges, taxes and fees. Illustrations using typical examples e.g. median or average holding period for mutual funds would be very revealing. Apart from paper disclosure, it would be useful for mutual fund companies to be obliged to provide historical Returns calculators on their website that can incorporate holding periods and tax rates for funds.

The Investor Education Fund content, created especially for consumers by an organization funded by the OSC and copied on the Globe and Mail website, is positively befuddling in its What will it cost to invest in mutual funds? First it says "When your account statement shows you your return, what you see is what the fund made after costs." Then it lists the top three costs for mutual funds and includes the front- and back-loads that are NOT part of Returns figures cited by one and all. Thanks for the help. Please don't help us any more.

The mutual fund company Brandes Investment Partners includes a note at the bottom of its Fund Performance document - "The indicated rates of return are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns." But what the heck does the statement preceding it mean - "Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments"? We are left wondering how the MER and other expenses were treated in calculating those Returns. To figure it out, you have to already know that the MER causes a "change in unit value".

I've taken some liberty with regards to the meaning of Black Comedy, but let's try to avoid the approach of Humpty Dumpty in Alice In Wonderland:`When I use a word,' Humpty Dumpty said in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'

`The question is,' said Alice, `whether you can make words mean so many different things.'

Monday, 14 February 2011

Bet you never thought that Groucho Marx ever said anything bearing on mutual funds. Never did I till I pondered this quote (on Wikipedia): "Please accept my resignation. I don’t care to belong to any club that will have me as a member."

Why do mutual funds want us as members? The answer sadly for most mutual funds, is to collect management fees and not to provide the supposed membership benefit of a fair investment return. Consider the simple arithmetic. Funds charge a fee based on assets, such as 2% per year. Thus, for example, if a fund has $100 million in assets, the managers collect a $2 million fee annually. Boosting assets raises fee pay for the managers. There are two ways to boost assets - 1) investment return, 2) sales of fund units to the public. The question then is, which is easier?

For option 1 generating investment return, as long as the fund invests in something it will gain a certain return somewhere around the market, but beating the market is very difficult, some say impossible on average. Going from 6% market return, approximated by simply investing in a broad range of holdings within the particular asset class, to 7% (outperformance by 1%), requires a lot of effort and/or skill, or luck (if you believe in efficient markets). In fact, actively managed mutual funds have been shown in many many studies not to be able to outperform by much (e..g read Richard Ferri's new book The Power of Passive Investing which slices and dices US actively-managed mutual fund performance against passive index investing every possible way, citing those numerous studies) even before fees. The one-third of funds that were actually successful in outdoing a US S&P 500 index fund from 1985 to 2009 (graph p.38 of the book) only averaged about 1% per year extra return and the very best only attained under 5% per year extra return. Two-thirds of the active funds lagged the index fund - by an average 1.69%. That's before sales commissions and income taxes, which would knock a bunch more down into the lagging side. The net effect on fees of 1% outperformance / $1 million excess return (which raises assets by 0.01 x $100M) is 2% of that extra $1 million or only $200k.

Option 2 is to raise assets by marketing and sales. Through advertising tailored to highlight its winning funds, companies can stimulate fund inflow. Winning funds are defined advatageously - they are compared only to other funds, not market indices, which means half can be above average as opposed to only the third when compared to indices. When a fund's performance almost inevitably falls behind it gets terminated or merged into another more successful fund to incite investors to stick with it and not withdraw their money. New funds are constantly being created or incubated to find some that outperform so they can be featured to attract new money.

How much extra effort is required to gain more than $1 million in new assets - and thus be ahead in garnering fees - by advertising and marketing and what is the comparative chance of success? For one thing, the public is constantly being motivated to contribute, being told to save for retirement, especially at this TFSA/RRSP time of year, when the investment decision becomes only a question of which investment to buy. Those dollars are probably easier for the fund company to grab. Furthermore, the process is much more under the control of the fund company than fickle markets are, so it's likely a lot easier to generate more fees with option 2. In sum it appears that mutual fund companies are much more marketing organizations than asset management / portfolio management companies.

Maybe the search for successful active management amongst mutual funds is looking in the wrong place. Ferri himself remarks that "Most of the great managers aren't for hire by the general public. The truly talented managers like to fly under the radar as long as possible to keep their assets manageable." He also quotes famed Yale University endowment manager David Swensen, who said "Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high quality active management decisions." A book I reviewed recently, Pension Revolution by Keith Ambachtsheer, followed the same thinking when discussing pension funds. He found that good governance, which includes properly motivated fiduciary-bound managers, made a big difference to performance. Well-governed pension funds achieved 1% per annum excess risk-adjusted return (he thinks 3% is possible for the best governed), though even the average pension fund achieved 0.2% excess return after fees and expenses. The problem with mutual funds, as Ambachtsheer puts it, is the managers' conflict between producing good returns for clients and profits for themselves. If individual investors are the "dumb money" patsies of the investment world that the "smart money" active investor eats for lunch, then mutual funds are the "conflicted money" that they eat for dinner.

Maybe Groucho had the right idea with respect to actively-managed mutual funds.

1) TMX as an investment - We can buy shares in the TMX, which has been doing rather well (latest Q4 results here). Will the combination do better? The merger press release talks of synergies and cost savings, as they always do, but many corporate mergers do not succeed (Deloitte says it's about half). Key issues: Will the business cultures fit? Will the technologies fit (what is the essence of a securities market if not a computer and communication/network system)? The old IT joke applies - "God could not have created the world in seven days if He had had an installed base." Blogger Larry Macdonald took a look at TMX Group last November. Wonder if he bought in and made money. The Google stock chart for TMX looks enviously enticing.

2) Inter-listings - If the combination results in there being more companies listed in Canada on the TSX as the press release suggests then that will be good for investors in Canada. Securities sold in Canada can be held in all those registered plans the federal government has created. There is no cost-effective way at the moment for Canadians to buy foreign securities to be held in registered accounts (you have to do this through an agent on the phone and pay commissions that can easily amount to hundreds of dollars), apart from US-traded securities which we can buy cheaply online. The markets in the UK and Canada will of course continue to operate separately, not as one giant market, due to the fact that the companies must comply with the local regulatory requirements, which for the TSX is Ontario/Ontario Securities Commission. Whether a company will choose to go through all the initial and on-going extra cost of registering and complying with the different local regulatory requirements is debatable.

3) Market liquidity - More investors create more trading volume and decrease bid-ask spreads aka investor costs as well as making it easier to buy/sell shares. But will more investors, presumably from outside Canada, show up in the TSX after the merger? That's not obvious.

4) Trading fee effects - If the combined LSE-TSX lower their costs and in turn lower the charges they make on trading for brokers or on listing for companies, that may increase the trading volumes and liquidity, as well as number of companies listing, both to the benefit of us individual investors. The TSX, LSE and all public exchanges are increasingly are increasingly in competition with one another and with alternative exchanges and private deal making networks (e.g. project Alpha described in Canadian Business Online by Jeff Sanford). More competition equals better outcomes for investors.

5) Investor protection - It cannot get worse than it is now for Canadian investors due to the weak laws and enforcement in Canada. To the extent that existing TSX companies decide to Inter-list and become subject to the UK's FSA regulation that will be a benefit.

From the viewpoint of the Canadian citizen, as expressed through our governments, I cannot see why exactly it would matter that, as the Globe and Mail's Boyd Erdman article (linked at the top) puts it "some key levers of control would shift outside Canada". As he also notes, many other national stock markets have already merged or been bought out, including Italy's Borsa Italiana by the LSE. If anything, a stronger, better capital market would be a more likely result for Canadian companies and investment in Canada. The government should probably encourage the merger instead of blocking it.

In short, it's hard to see any downsides for the individual investor, unless I've missed something, and there are some possible upsides. Thumbs up.

Update 15 Feb: best article I've seen on the Canadian regulatory issues being raised - here on Westlaw. Not a single word that any concerns exist in the UK. It's all about Canada. Those xenophobes who fear foreigners, especially Arab foreigners, taking over, may find comfort, or extra fear, from this December Telegraph article on the mistrust and machinations amongst LSE shareholders in Abu Dhabi, Dubai and Qatar. Another excellent Telegraph article puts the proposed merger in a global context.

Tuesday, 8 February 2011

An important subject but an opportunity missed. I was very much looking forward to this book, especially as the authors probably know at least as much as anyone about accounting and investment fraud. The sub-title promised much value to the individual investor - "Cons & Cheats and How to Protect Your Investments from Them".

Alas, the book left me disappointed. There is far too much ranting - however justified and true - against corporate crooks, lackadaisical regulators and accountants and the new IFRS accounting standard and too little of the detailed nuts and bolts dissection of how scams can be detected in advance for the investor to be able to avoid being taken in. We are left feeling vulnerable and frightened but not nearly enough better armed to defend ourselves.

That's a shame because the Rosens, especially the elder more experienced Al, could walk us through some case studies (there is one - National Business Systems - too briefly dissected in an appendix) they've encountered e.g. with excerpts from financial statements showing the telltale signs of danger. That would be really useful, for instance, when yesterday I blogged about Matrix Asset Management and the fact that it has reported transactions with related parties, an area that the Rosens state is often dangerous. In the absence of more specific guidance from the book on how to assess whether the transaction is bad or acceptable, should the investor stop right there and reject Matrix as an investment possibility? With this and other cautions regarding the latitude many if not all businesses have to manipulate their financial statements, we'd likely end up rejecting any investment except GICs as too risky. The Rosens don't say that is actually the best approach these days, though they do say this (page 200): "In the 1950s and 1960s, individual Canadians regarded the financial marketplace with grave mistrust. It took a major effort to encourage the public to invest in equities. Are we heading back to those days?"

The dust cover has the most intriguing inside dust cover photo (see scan of it below) I've seen in a long time.I hope they are on site in an office of one of the cons and cheats and not in their own office! (To complete the image of the hard-bitten experienced detective, they could have rolled up the sleeves and loosened the tie. ... Wonder if they've thought of a TV series?)

Surprisingly, the book makes no attempt to quantify the fraud problem, except to list a number of known cases. Maybe statistics would be difficult to find given that so much goes undetected but that would bolster a case which might be dismissed by authorities as merely the complaints of someone whose recommendation to reject IFRS as a replacement for GAAP was not followed (there is an awful lot of ranting about IFRS in the book).

Surprising also in its absence, and something I would have wanted in a book purporting to provide practical protection advice, is a chapter or an appendix with links to investor protection groups, discussion forums, complaints bodies, ombudsmen and references to pertinent articles or books.

The book does have practical investor value - there is a fair amount of pointing to specific balance sheet, income statement and cash flow lines with indication of how they can be dishonestly manipulated. It's just not extensive and detailed enough, i.e. a bit more "textbook" is needed. Cutting the polemic content word count down to about a quarter would leave a lot more space for the practical.

Bottom Line: I have to applaud its important message and the truth it speaks but as a book it could be a lot better.

Monday, 7 February 2011

We all know the old saying "don't get mad, get even". There has been a lot of justified complaining about high mutual fund expenses in Canada. It so happens that a number of the companies that charge those high fees - all the big banks and insurance companies amongst them - are public companies whose shares we can buy. Presumably those high fees go into the coffers of those companies. So should we investors simply invest in those mutual fund sellers to get our own back and make decent returns?

The answer appears to be yes for some and no for others.

Yes - Royal Bank of Canada (RY) vs RBC Canadian Dividend (RBF266), a flagship mega fund with $10.4 billion in assetsThe TMX.com chart shows that over the past ten years the price of RY has risen a lot more than RBF266 (even excluding dividends, which are sure to have been higher for RY than RBF266). It is also interesting, and perhaps significant since RBF266's MER at 1.7% is appreciably less than the typical 2+% equity mutual fund MER, that RBF266 outpaced the TSX Composite by a good margin. The Morningstar.ca entry for RBF266, which includes all dividends/distributions in Total Return figures, confirms that fact - 10-year performance was 8.16% annualized vs only 1.64% for the TSX. An RBC Investor Deck shows total returns for RY to Dec.1st, 2010 at 13.0%.

IGM Financial (IGM) vs Investors Group Dividend A or C (IGI008), another mega fund with $13.5 billion in assets. Here's another chart from TMX.com. Over the past ten years IGM seems to have easily outstripped INI008, which has not even done as well as the TSX Composite (the blue line). Perhaps the 2.78% MER of INI008 has something to do with that?

No, or perhaps more precisely, it's hard to tell which will lose you more money - Matrix Asset Management (MTA) vs GrowthWorks Canadian (WVN612)It seems to be a choice between the long, slow, steady slide into oblivion of WVN612 (see this Morningstar.ca chart - even the highly volatile TSX Small Cap Index has eventually recovered and is up) vs the yet-to-be revealed hazards of MTA.

The chart above doesn't tell the whole story of WVN612's sorry life. Prior to 2005, it was the Capital Alliance Venture fund, which led an equally horrible life (Returns for CAVI to November 29, 2005 were: 1 yr: -7.7%; 3 yr: -9.8%; 5 yr: -13.8%; since inception: -1.3% per bottom of page 4). It's funny that CAVI founder and longtime president Denzil Doyle was inducted into the Order of Canada in the same year - 2005 - that the failing fund was sold to GrowthWorks. Disclosure: I invested money in CAVI way back in the 1990s and am a disgruntled loser!

Now MTA manages WVN612 along with a whole collection of similar Labour Sponsored Investment Funds (see Globe and Mail's How Risky is an (sic) LSIF?). Though the funds lose money, the management company doesn't need to, since it draws juicy fees e.g. WVN612's MER is currently 4.96% per annum. That should mean juicy profits for MTA, right? Um, no, MTA has eeked out losses or small profits since its reincarnation on the TSX in January last year after spending years as Seamark. (see the Google Finance chart below of how successful Seamark was for investors)MTA's stock price is down 9.3% from its initial price, though hey, it is ahead of WVN612 which has lost 14.7% in that time.What is going on at MTA then? It is hard to tell without spending a lot of time in the financial statements. However, I would be worried that the individuals who manage MTA, the executives, having milked the LSIFs (which is why those failures have been kept alive), will garner most of the benefit from the public company, all perfectly legally no doubt. Various worrying signs are visible - transactions with related parties, extra non-GAAP figures like recurring income before taxes in the income statement to more favourably portray company results. Pass me my ten-foot pole please!

Saturday, 5 February 2011

In ancient Greek mythology, Sisyphus was an evil man condemned by the gods for his crimes to roll a boulder up a hill, only to have it roll back down on nearing the top and then have to start all over, repeating this forever.

Unfortunately, today in Canada, Sisyphus has been reversed - it is the investor protection advocates, those representing the victims of financial crime, who seem to be condemned to forever rolling the boulder of reform up the steep hill of governmental and bureaucratic indifference.

Having long been aware of such investor advocate stalwarts as Ken Kivenko at CanadianFundwatch.com. Peter Benedek of RetirementAction.com and Marc Ryan of IndependentInvestor.info, I've just come across Pamela Reeve (website here) and her current efforts to get the Investor Advisory Panel of the regulatory body the Ontario Securities Commission on an effective track. To no avail it seems ... after reading her thoughtful and detailed open letter to John Stevenson of the OSC about the IAP, I sent her an email asking about response and progress. A speedy reply the very day came from her (unlike, I might note, responses from the OSC at various times I have emailed them, which took from a few days to never). The essence of the result - a new IAP with no resources and no independence from the OSC (see the OSC page for the IAP here). She also copied me with a letter to the Ontario Minister responsible Dwight Duncan and his dismissive response months later.

Having worked for many years in corporate and government bureaucracies, at times even drafting responses such as the one she received from Minister Duncan, it is sadly evident to me that as yet, there is no will at the top government level to improve things for investors. Meantime, the OSC and other organizations who can and should do something, follow the "keep-them-talking-forever" strategy, paying lip-service only to investor protection. The new OSC IAP amounts to an exercise in co-opting some investor advocates. It's funny that the IAP should get a princely $50k when industry body IIROC is willing to put $3.75 million into FAIR http://faircanada.ca/about-us/background/. The new Canadian Securities regulator doesn't look like it will do any better either, as this article by Independent Investor's Marc Ryan says - http://independentinvestor.info/content/view/955/1/.

I have to admit that I have not devoted much blog space in the four years I have been writing this blog (yup, the 4th anniversary just passed) or personal time to the investor protection system (though I have been burned by the great con of LSIFs and a company called, ironically, Intelligent Detection Systems). I just assume that investor protection essentially does not exist right now in Canada and instead look for financial products and services that are likely legitimate. There are a few I believe and my aim as a blogger is to find and write about them!

Thanks to Pamela, Ken, Marc, Peter and others labouring mightily on our behalf. Hopefully, one day a tipping point will be reached and that rock will reach the top to roll down the other side of the hill and knock down a slew of bad guys hiding over there.